Crisis Management

WHEN GASOLINE PRICES RISE to $2.25 or more for a gallon of regular gas, American drivers may be forgiven for thinking that their world is coming to an end. But the role of oil in the world economy is often over-rated. Consider the size of the Saudi Arabian economy -- 45% of the desert nation's gross domestic product consists of oil production, and the whole economy produces only $286 billion in goods and services, much of it with the help of 5.5 million foreign workers. Taiwan, with about the same number of people, and no energy resources to speak of, has a GDP twice as big.

Energy is an input, not the whole economy.

Until 1973, energy consumption rose in lockstep with GDP for most industrial nations. That was the easy way to grow. Energy was the least costly of economic inputs, therefore using more energy was the cheapest path to a more profitable product.

Sudden increases in the price of oil in the 1970s broke the relationship between energy and output -- much to the surprise of many energy economists. The world adapted, gradually but thoroughly. At first, high prices summoned geologists and engineers to find new supply sources; later the abolition of price controls in the U.S. rearranged the economics of oil in the ground. The U.S. could import more cheap foreign oil and avoid the forced exploitation of expensive domestic oil.

Oil actually proved to be abundant, and many nations -- Mexico, Norway, the United Kingdom, Indonesia, Russia, Venezuela and Nigeria to name a few important ones -- were as willing to supply it at low prices as they had at the peak of the energy bubble. They had oil and they had invested in production facilities. They could not eat it or afford not to sell it.

OPEC, the so-called oil cartel, had little if any power to punish cheating members, limit the production of non-members or restrict world supply some other way.

In economists' terms, the price of oil is driven by demand in the short term, and demand was generally weaker than supply from about 1982 to 2003.

Other factors of production became more important than energy. In the two decades of low oil prices, the most profitable way to increase productivity was to rearrange labor costs. Japanese firms moved factories to the U.S., Korea, Taiwan and China; Europeans moved factories to the U.S. and to Central Europe. When the U.S. moved production to Mexico, then to China and elsewhere in Asia, that made room for new jobs coming in.

In general, European and Japanese industrialists moved to the U.S. to take advantage of the world's most productive labor force, while they moved to Central Europe and Asia seeking cheaper workers. American industrialists moved their less productive jobs overseas, in part because the foreigners were bidding up American labor costs, and in part because there weren't enough people to fill all the jobs that existed in the 1980s and all the jobs that were created between 1990 and 2001.

The "giant sucking sound" made famous by Ross Perot was actually the sound of a giant valve operating to relieve the inflationary pressure of too many jobs chasing too few workers.

In the past few years, however, the price of energy has been rising, especially in terms of the falling U.S. dollar. It's a demand-driven price again, but in a world economy that has expanded faster than expected.

The sudden increase has brought the return of loud worries about the limited supply of oil, and the return of predictions that oil production will reach an inevitable and insurmountable peak sometime soon. Like the indefatigable Malthusian prophets who believe that the world's population will starve after the world reaches an inevitable and insurmountable peak in food production, those who project the coming energy crisis are not hindered by past failure. Their missing previous deadlines simply makes them more certain that the eventual day of reckoning is nearer to hand.

If world oil production peaks soon, it is quite possible that there will be problems. The world might need two decades for a crash program to develop new liquid-fuel sources. The U.S. Department of Energy estimates construction of a single substitute-fuel plant could cost $5 billion and require the better part of a decade to build. Such a plant might yield 100,000 barrels of liquid fuels per day -- a drop in the world's energy bucket if a world oil shortage would quickly escalate to tens of millions of barrels per day.

But build we must, say many of the worriers, stressing their view that the market cannot create new sources of energy in time to avert an economic crisis. Whether their favorite thing is a hydrogen economy or the creation of synthetic fuels, they call for government investment and government subsidy to bring the price of alternatives within reach of the marketplace.

It's a big job, calling for a big government with big ideas -- just the kind of government we should have learned not to trust. The pathetic excuse for an energy bill pending in Congress is replete with special subsidies and attempts to manage the future.

Energy is traded in markets, and markets will mitigate the economic impact with price increases. There will never be a serious long-term shortage of energy as long as we do not impose price controls or impose a political vision of new fuels and technologies.

There will just be higher prices, and some uses of oil will be priced out of the market. This will be no disaster: All users of energy will be forced to conserve it. At the same time, price increases will drive capital and capitalists toward newly attractive investment opportunities in energy supplies, just as low prices drove investors away from the oil business for the last two decades.

Profits are the appropriate spur to timely action. Before profits can be earned in the market, energy investments are just welfare programs for geologists and engineers.

The messy, chaotic mechanisms of the market, which nobody can predict or control, offer the safest and most efficient routes to energy security.

The End of an Era

The Big Board is just another board now

THE WOLVES OF WALL STREET suddenly find themselves transformed into lost lambs. Now they know why they were paying all that money to former stock-exchange President Richard Grasso. As leader of the pack, Grasso was protecting the specialists and floor traders, keeping their hunting grounds safe from bigger predators.

Grasso brought as much automation as the New York Stock Exchange could stand, and he stood between the exchange and all its would-be competitors.

Now the new leaders of the exchange have given up on Grasso's long struggle. In a deal announced last week, they will merge with one of those competitors, the electronic exchange called Archipelago. Members of the Big Board will get $300,000 for each of their seats and stock in a public company.

Nobody should know better than the members of the New York Stock Exchange how ruthlessly efficient markets can be in evaluating public companies. Stock in NYX Inc. will be worth something, but after real competition hits the Street, it won't be worth much.

The real value of the Big Board these past two centuries has been the exclusivity of the club and its monopoly on trading most of the popular stocks. Regulation and competition have eroded that monopoly and the new deal will end it.

As it did on Main Street, the electronic economy will eliminate middlemen on Wall Street. Specialists and floor traders will soon go the way of travel agents and jobbers, and stockbrokers will be next.

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